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Equity is money that remains after all assets are liquidated and all debts have been paid. Equity is the sum of a company's net assets and its liabilities. You may also refer to equity as stockholders equity or shareholders' equity. It is the remaining claim of an owner of a company after all debts have been paid.
Let me give you an example of equity.
Check out the assets and liabilities of ABC Corporation as of 30 September 2019. On that date, its total assets stood at Rs 15,000 Meanwhile, its total liabilities--including loans and taxes--amounted to Rs 75,000. The equity of ABC Corporation as of 30 September 2019 was Rs 25,000, i.e. The equity of ABC Corp. on 30th Sept'19 is Rs 25,000.
Capital is essential for any company to grow or start its operations. There are three main options for raising capital:
1. Initial investment in company
Imagine Alok is planning to start a business. Bindu, Christina and Dilshad each contribute Rs 10 lakh. All four of them then have equity investments in company.
They may decide to raise additional capital later in life to expand their operations. The next source of equity is the choice of borrowing from private investors or listing on the stock exchange.
2. Borrowing from Private Investors
Private investors can include individuals, institutions, pension funds, university endowments and insurance companies. The founders of the company promise to give back a portion of their ownership in return for the investment. Each investor gets a proportionate share of the company's ownership based on their investment.
Private equity investors need to have a thorough understanding of the business environment. To be eligible to invest, they must meet a certain minimum net worth.
3. Listing at the stock exchange
A company that is listed on the stock exchange aims to raise capital. Many companies are small and start out as private businesses. Some companies grow and become public.
It is important to look at other investment options in order to understand why equity can be a great avenue for investment. Some of the most popular non-equity investments instruments in India are bank fixed deposits (FDs), and post office savings schemes.
All non-equity instruments have been considered safe and low-risk investments. They generate wealth at a lower rate than equity instruments. Fixed deposits, for example, can earn interest earnings of about 6-7%. According to a Live Mint article dated March 3, 2019, the cumulative annual growth rate for the Sensex (CAGR), has been higher than 16% in the past 40 years, from 1979 to 2019.
Fixed deposit interest earnings are subject to income tax. The investor's tax bracket determines the tax rate. Fixed deposit income will be subject to the same tax rate if you fall within the 30% tax bracket. Equity investments have different tax treatment. If you have equity investments that exceed one year, you can either sell or redeem them. Since you have been invested for more than 12 months, your profits will be considered long-term capital gains (LTCG). Current tax rules apply to gains exceeding Rs 1 lakh.
Safe investments may not be so safe. Only bank deposits up to Rs 55,000 per investor are covered. Insurance coverage is provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of Reserve Bank of India. Deposits exceeding Rs 5 lakh in public-sector banks may be lost if things turn sour.
Equity is a great investment tool for retail investors. These investments can be subject to market risk. However, investing in the stock exchange could lead to higher returns and lower taxes.
Before investing in equity, it is important to consider the following:
Investment is, in essence, a long-term game. Equity is a good investment for anyone who has a long-term investment plan.
The time frame for investing decreases as you get older. As a general rule of thumb, allocate 100 - 40% of your portfolio to equity. A 40-year-old could, for example, allocate between 100 and 40 )%--, which is 60% of their portfolio, to equity.
Equity investments can be subject to market risk. Blue-chip and large-cap stocks are good options for those with moderate risk appetite. These stocks are less risky than others.
There are many ways to invest equity in India. Below are the top options:
Shares can be described as a form of partial ownership in a company. A shareholder is someone who invests in shares. The amount that you have invested in the company determines how much ownership you have.
Market captalisation is the most common way to classify shares. This term refers to the market value of all outstanding shares of stock in a company. This simple formula is used to calculate it:
Total shares outstanding x Current market value of one share
Let's say ABC Corporation has 100 shares outstanding. The market cap for ABC Corporation is Rs 1000 if each share has a market price of Rs 10.
Shares can be classified based on their market capital.
It is easy to invest in equity with mutual funds. These funds are ideal for investors without stock market experience, or who don't have the time or patience to do market research. Mutual funds are investments made by retail investors. The capital is then allocated to other assets.
These funds can be offered and managed through asset management companies (AMCs). AMCs may pool funds from different investors to create mutual fund portfolios. A fund manager is responsible for each portfolio. The mutual fund manager invests the accumulated capital in various assets, such as bonds and equities. Equity mutual funds, for example, are funds that invest mainly on equity shares.
Mutual funds can offer many benefits to investors:
1. The investor's money will be safe as expert fund managers make investment decisions.
2. Mutual funds provide diversification. Mutual funds reduce risk exposure by spreading your investment across multiple assets. Mutual funds offer diversification benefits that are not available to pure equity funds. Equity mutual funds invest across stocks. This decreases the impact of a stock on the fund’s net asset value (NAV), simply the per-unit market value.
3. A mutual fund investor can either invest in a lump sum amount or in smaller amounts via a Systematic Investment Plan. An investor can invest in a mutual fund by either paying a lump-sum amount or investing small amounts through a Systematic Investment Plan (SIP).
Shares and mutual funds are the cash market. Options and futures allow investors to buy and sell future equity stocks/indices. Both can be used to buy or sell a stock/index at a future date and at a fixed price. There is an important difference between the two: futures and options.
Take the following example: An option contract is where an investor opens a call option for stock purchase at Rs 50 per share. This is the strike price. At the moment, the share trades at Rs 30. The premium is the amount that the investor must pay at the time they open the call option. The premium is forfeited if the buyer doesn't buy shares of ABC Corporation by the 30th April 2020. The investor can also buy shares at Rs 50 if the stock price reaches Rs 60. The investor can then sell the shares on the cash market to make a profit of Rs 10.
On the other hand, a futures contract is mandatory. You might enter a futures agreement to buy a stock at a certain date and time. If the contract has not been closed before you can complete the transaction, you will be required to do so.
Experienced investors can use options and futures contracts. These instruments can be used to speculate on the price movements of the underlying stock and/or hedge their current investments. Arbitrage funds
Arbitrage funds are mutual funds that take advantage of market volatility. It seeks to generate returns on the basis of price fluctuations in cash and derivatives markets. An arbitrage fund could buy and sell the exact same stock on different exchanges, for example. It might also purchase stock in cash and then simultaneously sell it in futures. This allows investors to profit from price fluctuations resulting from market inefficiencies.
All investments can be risky. Here are some examples of the risks involved in equity investments.
A slowdown in the economy, for instance, could have different effects on the stock market. These macroeconomic factors can have a broad impact on all sectors but they might not have the same effect across them. A company operating in a stable sector may be affected by management problems or get into trouble with the regulators. Investors should diversify their portfolios to reduce their exposure to any stock or sector.
The policies of the current government have a negative impact on businesses. New legislation can have a negative impact on the prospects of certain companies or sectors. Mining companies might find it more difficult to make profits at a faster rate if there is a stricter environment law. Let's say the government decides that a sector was no longer protected. In this case, companies from indigenous countries with lower efficiency could lose out to foreign competitors.
When the rupee appreciates, it can be detrimental for companies that rely heavily on imports of raw materials. Exporters could see their profits decline as the rupee appreciates. The rupee's appreciation can have a negative impact on the economy in general, as the rupee is used to translate into higher crude oil prices.
Inflation can be defeated by adding equity to your investment portfolio. Inflation is wealth's enemy. It reduces your money's purchasing power over time. Equity, unlike other investment vehicles can provide inflation-adjusted long-term returns. Although seasoned investors can trade or invest in equity directly on the stock market, less experienced investors could opt for mutual funds. Remember to consider your financial goals and requirements. This will allow you to create an effective equity investment strategy.
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